Nice little earners in the niches
Sunday 13 August 1995
Sales growth is an exciting development for both Eurotherm, at 469p, and Druck, at a weighty pounds 18.20, because both have gross margins in excess of 50 per cent.
Eurotherm's Swedish chief executive, Claes Hultman, says that based on his formula of selling-price less direct material and labour costs, his company makes between 62p and 63p in profit on each additional pound of income. Stockbroking analysts can find it hard to adapt profit forecasts quickly enough when the business cycle turns higher.
Druck shares shot higher recently when the group reported profits of pounds 7.3m against expectations of pounds 6.4m, helped by a similar "operational gearing" effect.
Part of the excitement with both companies is that they are operating in markets that are moving out of recession. As suppliers of instruments for the control and measurement of indust- rial processes, both companies are influenced by the capital goods cycle. This lags behind the normal economic cycle and partly explains why capital goods companies are doing well now, a few years into the recovery.
However, both companies have traditionally been able to resist recession by targeting new customers. Mr Hultman describes how Eurotherm has shifted its emphasis over the last few years from steel to pharmaceuticals and then to paper products groups, as each of those industries has enjoyed periods of prosperity.
Slightly contradicting this usual pattern, Eurotherm had a tough time in the early 1990s recession. This was partly because of its severity, but also because the company had rather lost its way, culminating in a sharp profits decline in 1991.
Mr Hultman was recruited to stop the rot. This called for drastic action to restore profitability. Overheads were slashed, including trimming the workforce from 3,000 to 2,000. About pounds 10m of sales in unrelated activities were disposed of, and a further pounds 15m of low-margin sales were discontinued. The results were dramatic, with pre-tax profits growing from pounds 7.15m in 1991 to pounds 26.1m for the year to 31 October 1994, while sales in 1994, at pounds 168m, barely exceeded the 1990 figure of pounds 164m.
The next stage in Eurotherm's rehabilitation was to improve sales growth. Economic recovery has helped, but there has also been an active programme of new product development. The group is a world leader in temperature control equipment (the original business) and in recording instruments for the paper industry, among others. Over 80 per cent of output goes overseas.
Overall sales growth has picked up from 6 per cent last year to over 11 per cent in the first half of 1995. The shares are highly rated on a historical price-earnings ratio over 21, but forecasts of profits reaching pounds 34m and pounds 40m this year and next will bring that down to 18 and then 15. That does not look dear for a group that could grow at 20 per cent a year for many years.
Druck, which specialises in pressure transducers and transmitters, is smaller but equally export-orientated and arguably growing even faster. The latest results were accompanied by news of an order book up 51 per cent on a year earlier.
In the light of better-than-expected 1994-95 figures, one analyst raised his forecast from pounds 7.6m to pounds 8.8m, implying 90p of earnings. But he conceded the figure could easily be pounds 1, which would drop the p/e to 18. For a company with Druck's pros- pects, even that rating is looking miserly.
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